The EPA just released its RFS2 data and they reveal some interesting facts:
The 2013 RVO (Renewable Volume Obligation) was barely reached. This is unusual because 20% of production is allowed to be carried over into the next year. This should create a relative shortage in 2014 if the current RVOs hold.
Ethanol production only reached 97% of its 2013 RVO. This is unusual given the relatively high ethanol margins that existed throughout 2013. This should create a relative shortage, and may help explain why D6 RINs still have value given the recent proposal by the EPA to substantially reduce ethanol's 2014 RVO.
The Biomass Based Diesel production reached 140% of its 2013 RVO. That means 20% was carried over into 2014, which should keep pressure on the D4 RINs at least through mid-February. The other 20% would have been used to satisfy the Advanced Biofuels D5 RIN RVO. Clearly the Blenders' Tax Credit encouraged production in the biodiesel industry.
Only 39% of the Advanced Biofuels D5 RVO was reached. Much of the underproduction may be due to the overflow of biomass based diesel RINs. A shuttered Dynamics Fuels plant also decreases supply.
Cellulosic Biofuel D3 RINS and Cellulosic Diesel D7 RINs barely even registered, reaching only 9% of the minimal 6 million gallon 2013 RVO. Cellulosic based biofuels represent the future of the RVO, but right now they are in their infancy.
Renewable Diesel 1.7x D4 RIN surged almost 300% from 2012. This trend bodes ill for Biodiesel 1.5x D4 RINs. As more and more renewable diesel capacity comes on line, there will be fewer and fewer D4 RINs for the less efficient biodiesel producers to capture.
Now that the final EPA numbers are out a few themes can be identified:
Ethanol production has likely reached a peak, and because of the "blend wall" issue will likely have its RVO cut going forward. This however does not mean ethanol margins will suffer. Corn prices have fallen dramatically keeping ethanol margins relatively high. D6 RINs have also maintained a relatively high price level. Theoretically they should be worthless, but I speculate that they have maintained their value due to 1) the relative shortage created in 2013 and 2) insurance against the EPA not cutting the 2014 RVO and creating another "blend wall" fiasco. That however is simply my theory, and it is pure speculation. I've talked to various people and no one seems able to explain why D6 RINs are holding their value. Please post a comment if you have a better theory.
Biomass Based Diesel easily exceeded its 2013 RVO, and yet the EPA proposed that its RVO remain fixed in 2014. Combined with the expiration of the "blenders' tax credit" and overproduction of D4 RINs in 2013, biodiesel margins have been crushed. I would speculate that either the EPA's RVO gets boosted to 1.7 to 1.9 billion gallons, the "blenders' tax credit" gets renewed or both. Failure to do either will likely harm Biodiesel margins for all of 2014. Fuel, feedstock and RIN prices may adjust accordingly to compensate for the loss of the tax credit, but so far that has not happened.
Higher margin Renewable Diesel that gets 1.7x D4 RINs vs 1.5x D4 RINs that Biodiesel gets is rapidly eating up the Biomass Based Diesel RVO. This will put tremendous pressure on higher cost soybean oil based biodiesel producers, which will eventually be forced out of the market if trends continue. That is why it is important for biodiesel producers like Renewable Energy Group (NASDAQ:REGI) to continue upgrading their facilities to process flex feedstock, and make acquisitions of firms that produce something other than Biodiesel. The recently opened Diamond Green Diesel plant, a JV between Darling International (NYSE:DAR) and Valero (NYSE:VLO), has a boilerplate of 135 million gallons per year. That single plant can consume approximately 11% of the Nation's "yellow grease," a feedstock also used in Biodiesel.
The refinery uses cutting edge technology to convert approximately 11% of our country's animal fat and used cooking oil into a fuel that has the same properties as petroleum diesel, allowing this green diesel to integrate seamlessly with Valero's existing fuel infrastructure, with distribution via pipeline to their consumer base.
Regardless of what happens with the ethanol and Biodiesel RVOs, those industries are capacity limited. Ethanol has the "blend wall" and uses food as a feedstock. Biodiesel uses either food or a highly limited supply of waste. Those are 1st generation biofuels, and have likely seen their better days. The pie will likely no longer be growing, and it will turn to a market share battle.
Cellulose is the future of the EPA's RFS2. The 2022 RVO for cellulosic biofuels in 16 billion gallons, an amount greater than today's ethanol RVO. Today, Cellulosic Biofuels basically don't exist, but that should change in 2014/15 as a few plants are scheduled to start or ramp up production.
Ethanol and renewable diesel can be made from cellulose, so over the next 6 to 8 years I would expect traditional ethanol and biodiesel firms to either evolve or dissolve. Because of this, I would expect established 1st generation biofuels firms line Green Planes Renewable Energy (NASDAQ:GPRE) and REGI to further consolidate the existing market and seek acquisitions outside their current line of business. The 1st generation biofuels producers simply must evolve into 2nd generation biofuels firms or face extinction.
2013 Q4 Biomass Based Diesel production exceeded Q3 2013 by 8%. Because REGI's 257 million gallon capacity represents 1/5th of the 2013 RVO for Biodiesel, I would imagine part of that 8% increase came from REGI's Q4 production exceeding its Q3 production. With the increased production and solid margins for the biodiesel industry in Q4 2013, combined with REGI's sizable inventory entering Q4 2013, I would imagine that REGI will exceed its "outlook" of 65-75 million gallons sold and an adj EBITDA of $25-$40 million. REGI produced 57 million gallons, reduced inventories by $17 million and sold 78 million gallons in Q3 2013. Entering Q4 2013 REGI had inventories of $60 million, or 12 million gallons using an average price of $4.95/gal. Because the tax credit was scheduled to expire, I would imagine REGI would reduce inventories as much as possible to capture as much of the high margins as possible. Given REGI had an adj EBTIDA of $49 million in Q3 2013 and gave an "outlook" for a Q4 2013 adj EBITDA of $25-$40 million, I speculate that REGI will exceed even the upper range of its "outlook." I would expect them to at least meet the $49 million adj EBITDA reached in Q3 2013.
In conclusion, the EPA's RFS2 production data gives a clearer picture of the renewable fuels industries. With the strong production of Biomass Based Diesel during a relatively high margin period, I would expect many biodiesel producers to exceed expectations for Q4 2013. That however may not help the stock prices of these companies. Margins have collapsed for Biodiesel, but remained high for Ethanol. Looking forward, investors in the biofuels industry should watch for:
1) Any changes to the EPA's RFS2 RVOs for 2014.
2) Any changes to the margins (already linked above).
3) Any changes to the Blenders' Tax Credit situation.
4) Any changes to the feedstock, fuel or RIN prices.
Depending on how the tax credit, RVO and margins develop over 2014 will have an enormous impact on the outlook for companies in these industries. Right now however uncertainty is likely preventing these companies from reaching their true valuation. Once/as those issues get resolved, I would imagine the markets will react swiftly to any news, good or bad. Bottom line, I would expect 2014 to be a volatile year for the biofuels industries.
Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Full Disclaimer and Disclosure Click Here.
Disclosure: I am long SYNM, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own Apr $12.5 calls on REGI